Here’s a graph showing the amount of “excess” (beyond required amounts) reserves held by U.S. banks. It covers quite a span of time, but it’s the best-looking one I found showing the relevant data. The graph also gives just a bit of sense of the extent of the unprecedented nature of money-pumping going on at the Federal level.
In fact this chart is still a bit out of date, since now, as of August 2009, banks have about 900 billion in excess reserves (when required amounts are somewhere near 50 billion), according to numbers on aggregate reserves of depository institutions by Donald Marron of Marron Economics, LLC.
The reason this catches your eye is that… almost all of the economics we were taught in college says that if you see reserves go up that much, you ought to expect incredible inflationary pressures.
Since the bank reserves aren’t circulating within the economy in the form of new loans, we’ve got gluts of newly printed money just hanging out within the banks themselves. Hanging out, waiting to flow into markets and the accounts of businesses, consumers.
Why Are Banks Hoarding So Many Excess Reserves?
This post is fully 10 months late, but I’ve just learned the specifics of this.
It used to be that the Fed only had two monetary tricks up its sleeve: (1) raising/lowering interest rates and (2) printing money to push into the system. Now there may be a third. (A third which is, essentially, really just a synthesis of these first two).
I’ve only just learned of this, but it might explain a whole lot in the debate over when inflation is going to kick in and why it hasn’t already, given the historically unprecedented amounts of new money in the worldwide system.
The U.S. Federal Reserve now pays U.S. banks interest on the amount of reserves they hold.
Since October 1, 2008, under the Emergency Economic Stabilization Act, the Federal Reserve Banks are required to pay interest on balances maintained at banks. This effectively gives banks an incentive to keep more money in their reserves. A lot more money. Because the banks can make more from the Fed’s interest payments than they can by lending the money out on the markets where they would get the measly near-zero rates currently on offer.
On the surface, the Fed move makes sense. One of the main problems going into the crisis were the insanely low levels of reserves banks were required to hold. As a result, the banks kept little by way of what you and I would call an “emergency fund.” This meant they had more operating cashflow and potential returns, but it gave them no buffer when loans and mortgages failed in droves.
Now, the pendulum has swung in the opposite direction. There are reports that the banks are “hoarding” too much of their money. In fact, these reports and complaints could be heard by analysts months ago. Remember all those complaints about banks not lending enough new money to small business, etc. yet? I’ve only just recently learned of this new Fed trick – the linchpin to this whole economic lending process – but it is no doubt part of the reason why.
A More Gradual Approach To Massive Inflation? Or Floods Breaking the Dam?
So when will the banks start lending out this money? Presumably, once market rates are higher than what the Fed has currently set. But wait. The Fed is setting the rate they pay the banks, too. So the Fed is in now in complete “effective” control of the banks’ lending practices! How’s that for a nice capitalist conclusion. Seriously, if the banks want to make a profit, they’re going to follow the highest interest rates.
But this just means that there’s one more tap from which you can drink a pint of inflation. Because for as long as the Fed wants the banks to hold onto these massive reserves, they’re going to pay the rates required. If they raise market interest rates in hopes of stemming inflation, they’ll have to raise the rates they pay banks as well. If they decide not to, the massive bank reserves – all that TARP money and more – will come flooding into the market anyway and we’ll still start to really feel that inflation.
Either way, the Fed’s new trick is just another money injection, another form of the same printing of money. Yes, this is how the Fed has always worked. Printing money is its modus operandi. It’s just that now it’s happening to such an extreme degree. Analysts have complained that the Fed has too much control over the economy; it doesn’t operate according to free market principles (because it sets the interest rates for the market, rather than allowing the market to do this itself). This is just another new way of doing that.
I’m not here to espouse any particular economic philosophy – I modestly say that I don’t know enough yet to really be able to soundly argue that. But what I can argue for is for the individual becoming more educated on matters that concern him/her (directly or indirectly). To me, this is an important piece of news in the financial landscape. I don’t know what its full consequences are, but I am sure they are significant. We will see! Until then, think about strategies for wealth protection.
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{ 1 comment… read it below or add one }
Very interesting article. The worldwide economical mechanism are not so clear to me but I can easily see some dependences between local economical systems. It is obvious that the more money appear on the market the less will those money be worth. But if this is not pumping new money but taking money from one hand to another, the situation could be different. I mean: they take money from reserves. That means they didn’t print any additional money but take some of existing amounts of $. Sure, those amounts are taken from stored reserves but are not going straight to the market. Those money would probably stay on accounts and get used only if necessary. I think that many banks will use them to earn, companies also to earn more money, so this will eventually be payed back in taxes, and the whole circulation will close. Or am I missing something?